A New Trade War

The United States has imposed 50% tariffs on Canadian products valued at approximately $20 billion. In retaliation, Canada has imposed tariffs of up to 50% on about 700 U.S. products valued at approximately $20 billion, marking the beginning of a new trade war.—reuters.com

Questions

1. What is a tariff?
2. How important is the United States–Canada trading relationship?
3. Why is this huge trading relationship under pressure today?
4. How do tariffs influence the importing country?
5. How do tariffs influence the exporting country?
6. Why could tariffs become a much bigger issue?
7. Explain the possible consequences of the U.S.–Canada trade war using a Kindleberger spiral diagram.
8. When was the Kindleberger spiral diagram first used?
9. What was the Smoot-Hawley Tariff?
10. Why is the Smoot–Hawley Tariff Act being mentioned again today?

Answers

1. What is a tariff?

A tariff is a tax imposed by an importing country on an imported good.

2. How important is the United States–Canada trading relationship?

The United States and Canada are one of the world’s largest bilateral trading partners. In 2025, the United States exported $333.6 billion worth of goods to Canada and imported $381.9 billion worth of goods from Canada, bringing total bilateral trade to $715.5 billion.

(To calculate total bilateral trade between the two countries, we only need to look at the exports and imports of one country, because one country’s exports are the other country’s imports.)

3. Why is this huge trading relationship under pressure today?

The pressure started to build after the United States imposed a huge 50% tariff on 550 Canadian goods, effective from August 22, 2026. A country that is hit with tariffs usually does not keep sitting on its hands doing nothing. As tariffs harm its exports, it may retaliate. This is exactly what Canada did. It responded with retaliatory tariffs of up to 50% on 700 U.S. goods. It is a dollar-for-dollar retaliation i.e., Canada imposed tariffs on U.S. goods worth roughly the same amount as the tariffs the United States imposed on Canadian goods. In this way, each country’s tariffs end up hurting the other country’s exports, and can start a cycle of retaliation.

4. How do tariffs influence the importing country?

Let’s take hockey sticks, which had previously entered the U.S. tariff-free from Canada under CUSMA— Canada–United States–Mexico Agreement.

Part (a) of Figure 1 illustrates free trade of hockey sticks between the two countries.

Suppose the no-trade price of a hockey stick in the United States is $170, while world price is $ 150 i.e., foreign producers can supply the same hockey stick for $150. Because the foreign price is lower, U.S. consumers begin buying imported hockey sticks. As imports enter the U.S. market, competition from foreign producers lowers the U.S. price from $170 to the world price of $150.

At a price of $ 150, the quantity of hockey sticks demanded is 780,000 and quantity of hockey sticks supplied is 648,000 The shortage of 132,000 hockey sticks is met through imports.

Now what will happen to this volume of imports as these goods get hit by tariffs?

The graph in part (b) of Figure 1 answers this question.

To remain profitable, the importer may pass on part or all of the tariff to consumers by including it in the final price they pay. So, the effect of a tariff is to raise the price above the world price, let’s say to $160.

The higher prices that result from tariffs discourage U.S. consumers from buying hockey sticks, so quantity demanded falls to 740,000, but encourage domestic producers to produce and sell more, so quantity supplied increases to 674,000, reducing the shortage to 66,000. The shortage is met through import, so imports from Canada decrease to 66,000.

So, tariffs raise the price of the good and decrease the volume of imports in the importing country.

5. How do tariffs influence the exporting country?

Part (a) of figure 2 shows that the no-trade price of a hockey stick in Canada is $130, while the world price is $150. Demand from U.S. buyers raises the Canadian price to the world price. Without tariffs, Canada exports 132,000 hockey sticks to the United States.

Part (b) shows how the U.S. tariff affects Canada, the exporting country. The United States now imports only 66,000 hockey sticks from Canada instead of 132,000. The fall in U.S. demand puts downward pressure on the price received by Canadian exporters. Suppose this causes the Canadian price to fall to $140. At this lower price, Canadian domestic production decreases, while domestic consumption increases, leaving fewer hockey sticks available for export—66,000 to be precise.

So, tariffs lower the price of the good and decrease the volume of exports in the exporting country.

6. Why could tariffs become a much bigger issue?

When a country adopts protectionism—raising tariffs to protect its domestic producers—it can invite retaliation from the other country whose export industries have been harmed. So, the other country may respond with retaliatory tariffs to protect its domestic industries. This can trigger a trade war, in which countries impose trade barriers, such as tariffs, on each other. U.S. imposes tariffs. Canada retaliates with tariffs. U.S. doesn’t tolerate retaliation and imposes even more tariffs and the cycle continues. As they repeatedly raise tariffs against each other, the volume of trade between them decreases significantly over time. This can be best explained using the Kindleberger spiral, illustrated in Figure 3.

7. Explain the possible consequences of the U.S.- Canada trade war using a Kindleberger spiral diagram.

Figure 3 adapts the Kindleberger spiral to illustrate a possible two-year outlook of the U.S.-Canada trade war.

Each rotation of the spiral begins in August and ends in August of the following year. Each spoke represents a month, and each node marks the beginning of a new month. The distance from each node to the center of the spiral represents the volume of trade in that month. As trade decreases, the nodes move closer to the center, creating an inward-moving spiral. The blue, green, and red segments represent 2026, 2027, and 2028, respectively.

A rough, unofficial estimate of U.S. exports to Canada is $27 billion, while U.S. imports from Canada are $31 billion in August 2026, giving a total bilateral trade of $58 billion in August.

U.S.–Canada trade begins at the node representing August 2026 on the blue segment. The $58 billion trade volume in this month is represented by the node’s distance from the center.

The next node on the blue segments represents September 2026. As U.S. protectionism reduces U.S. imports from Canada, while Canada’s retaliatory tariffs reduce Canadian imports from the United States, both countries trade less with each other, causing monthly bilateral trade to fall, say, to $49.3 billion, so the distance from the centerof the spiral decreases.

As the trade war continues, bilateral trade contracts month after month. The spiral therefore moves inward, with each successive node closer to the center, representing the fall in monthly trade. January 2028 node begins with the red segment. By August 2028, monthly U.S.–Canada trade has fallen to approximately $35 billion. Figures are hypothetical, of course.

8. When was the Kindleberger spiral diagram first used?

The Kindleberger Spiral was first published in 1973 by economist Charles P. Kindleberger in his book The World in Depression, 1929–1939. Figure 4 is the Kindleberger Spiral, borrowed from this book, and illustrates the month-by-month contraction in the total value of imports of 75 countries during the Great Depression, from January 1929 to March 1933. The U.S. Smoot–Hawley Tariff Act of 1930 is said to have contributed to this contraction in world trade.

9. What is the Smoot-Hawley Tariff?

In 1930, U.S. President Herbert Hoover imposed the Smoot–Hawley tariff to protect U.S. farmers and other domestic industries from foreign competition. Many countries retaliated by raising their tariffs on U.S. goods. The Smoot–Hawley Tariff contributed to the protectionist cycle that accompanied the collapse in world trade during the Great Depression. The total value of imports of 75 countries fell from about $3.0 billion in January 1929 to about $1.06 billion in March 1933.

10. Why is the Smoot-Hawley Tariff Act being mentioned again today?

Because economists and journalists see a historical parallel. In July 2026, Trump invoked Section 338 of the 1930 Tariff Act, the law commonly known as the Smoot–Hawley Tariff Act, to impose additional tariffs on Canadian goods. This historical parallel has raised fears that escalating tariffs and retaliation could produce a Kindleberger-style contraction in international trade.

Now take a short quiz to ensure you understand what you just read.